~ Investment Strategy

Macro Diary

I have been building tools for looking at the relationships between currencies, and one thing that has really stood out has been the behaviour of JPY. USD/JPY was until recently highly correlated with the two-year nominal interest-rate spread. But when the LDP won the election, something snapped. It is now not correlated with anything at all, except for Japanese equities, for which the movement in the currency is probably the causal factor. What is going on?

An obvious thing to wonder is whether there is a parallel with the last sustained period of JPY weakness in the mid-2000’s — the period of the yen carry trade. I have been wondering whether the sudden decline of JPY might be the result of yen-financed investments in non-Japanese assets. That would explain the sudden plummeting of the currency and perhaps the recent strength of global equities. This week, Andrew Hunt argues that Japanese banks have indeed been acquiring foreign assets — he says that all of the liquidity created by the BoJ’s recent puchases (which have been going on for a while — I watch its balance sheet every day) has been leaking abroad. This lends support to the idea of a carry trade that was suggested by the movements of asset prices. I suppose the story one could tell is that the election of the new government in Japan was a signal to domestic banks and foreign speculators that the Japanese currency was set to weaken, which gave the green light to JPY-funded trades at the same time at the strength of the US economy might be making the USD less attractive as a funding currency.

If there is a new JPY carry trade emerging — and the evidence is still quite preliminary — then it is something that could go on for a long time and snap the existing relationships in financial markets. Equities could remain strong in spite of their normal relationships.

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The fall in JPY has reignited talk of a “currency war”. I do not think this idea, appealing though it clearly is to journalists, is remotely helpful. In a war, countries attempt to do each other down in a zero-sum game. I am not sure that currency movements are a zero-sum game (think of Europe, for example, where currency flexibility in the periphery would probably help everybody, were it possible). In a currency war, countries would presumably try to do each other down deliberately — which is an idea that is apt to confuse, since neither the BoJ nor the Fed (another alleged warmonger) has explicitly set out to affect the currency markets. Their policies are responses to domestic conditions.

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Another unhelpful concept that I keep encountering is that of a “bond bubble”. People have been rabbiting on about this since 2009. But, again, I can’t see that it is a remotely useful concept. A bubble is a self-sustaining increase in prices associated with speculation. Bond prices are high because yields are low; yields are low because central-bank rates are low and expected to remain so. That seems to be a perfectly good explanation for why bond prices are high — so what is the “bubble” model supposed to explain? And there is no evidence of speculative behaviour in the bond market. Are taxi drivers talking about how much they made in Gilts? Has anyone written a book called “FTSE Actuaries UK Conventional Gilts All Stocks 360”?